The BundesbankBill Javetski and John Templeman
On Saturday, July 31, Europe awoke to its worst monetary crisis in years. Central bankers and finance ministers rushed to an emergency meeting in Brussels as a 10-day siege against the French franc threatened to topple the Continent's wobbly system of managed foreign exchange rates. Inside the closed-door session, nerves tightened as a year of currency turmoil and hundreds of billions of dollars of central-bank intervention came down to a single question: Did 40 years of Franco-German partnership at the heart of the European Community oblige the Bundesbank to continue unwavering support for a strong franc linked to the mark?
The answer wasn't long in coming. Banque de France Deputy Governor Herve Hannoun opened the discussion by calling on his German central bank counterparts to intervene to support the franc, lower short-term lending rates, and convene their policy-making council to reduce the discount rate. Before he could finish, one observer recalls, a sardonic voice cut him off. "You've forgotten a fourth item," said Bundesbank Vice-President Hans Tietmeyer--"that Germany should abandon the mark and its monetary sovereignty."
"AN ILLUSION." The mighty Bundesbank had struck again. A year before, it forced Britain into the humiliation of dropping out of Europe's exchange-rate system. Now, it was dashing French monetary pretensions and market expectations that Germany would at least cut rates to help the franc. In so doing, Tietmeyer was laying down the terms for the deal Europe's moneymen would eventually agree to over that weekend: a de facto float for Europe's currencies that would remove pressure on the Bundesbank to slash interest rates or intervene to help its neighbors.
As he sips coffee in his Frankfurt office on a late summer afternoon, Tietmeyer, who on Oct. 1 takes over from the steely Helmut Schlesinger as president of the German central bank, doesn't hide his satisfaction over the outcome of the Bundesbank's power play. The move dashed EC leaders' dreams of establishing a single currency and common central bank as soon as 1997. But "the idea that we could all stick to the exchange rates of the early 1990s was an illusion," he says in an interview with BUSINESS WEEK. In case the EC--or anyone else--is in need of a reality check, he repeats what Europe should by now have learned by rote. "If there is a conflict" between Germany's domestic and international monetary responsibilities, "of course we will always decide for the internal one."
That's a sobering message for a Europe that still hopes to turn its newborn single market into a wider economic and political union someday. Indeed, it's a message the entire Group of Seven industrial nations will have to ponder when they meet in Washington on Sept.25. On Sept. 21, the Bank of Japan cut its discount rate by three-quarters of a percentage point, to 1.75%, in a bid to rev up the flagging Japanese economy. But until Japan revives, the industrialized world's economy is now firing on only one cylinder: U.S. growth.
Even that is open to question if American exports to Europe continue to be hurt by high German interest rates that have sapped consumer and investment confidence across the Continent. But Tietmeyer, a key player in the global-coordination efforts of the 1980s, has little solace to offer. "A lot of people overestimate the role of the Bundesbank," he says. "Some people feel that our official rates are the key for the world economic recovery. I don't think so. The importance of German short-term rates--and especially Bundesbank rates--are overrated, no doubt about it."
Many others would disagree. Through its single-minded campaign against inflation (charts)--and by steamrolling politicians who have gotten in its way--the Bundesbank has at once established itself as the standard-bearer for independent central banks worldwide and as the most prominent symbol of German economic assertiveness in post-cold-war Europe. The Federal Reserve may regard low inflation as a means to sustainable economic growth. But, says a senior Fed official, "the Bundesbank sees it as an end in itself."
To beleaguered Europeans, such anti-inflation crusading translates into 12% EC unemployment (chart, page 46) and the worst recession in 45 years. True, to help ameliorate the slump that followed Germany's brief unification boom, the Bundesbank has lowered its benchmark discount rate by 2.5 percentage points in little more than a year, to 6.25%. But it still has a long way to go to prove that its hard-money philosophy won't drive Germany's exporters into a coma or weaken the economy so badly that it suffers a crisis of confidence and a run on the mark.
ZERO POINT. At worst, some fear, Tietmeyer may end up presiding over a spiral of devaluations that will threaten the EC's free-trade accord and set back four decades of progress toward a European ideal. "It's in the interest of other countries to be very careful," Tietmeyer says. "Competitive devaluations would not only harm German exporters but would bring inflation to other countries and undermine Europe's economic prospects."
But as the recession bites deeper, fewer and fewer Europeans are willing to heed Tietmeyer's warning. Indeed, reconciling the conflicting needs of inflation-plagued Germany and recession-wracked Europe will require a balancing act that will challenge every skill that Tietmeyer has learned in a career as a government official, banker, and Germany's top international money diplomat.
As German public-sector deficits swell toward 7% of gross domestic product--a level approaching Italy's--Bundesbank monetarists have found themselves with little choice but to ignore the money-supply targets that guided Schlesinger in his two-year presidency. But Tietmeyer remains adamant about halving Germany's 4% inflation rate and pursuing a long-term inflation target "that must be close to zero, no doubt about that."
Tietmeyer has a lot of time to try to achieve that goal. At 62, he is six years away from the bank's retirement age. And right now, the new president seems as firmly devoted to the central bank's creed as any of his predecessors. Embedded in Germany's constitution is a national obsession with stable prices and a sound currency. It is forged from two episodes of hyperinflation that destroyed Germans' savings and fueled Adolf Hitler's rise to power. Germany's yearning for stability is particularly strong now that it's engaged in the gamble of unification.
"DEEP STAGNATION." Stability in Germany, Tietmeyer says, can be the only response to the inchoate and inflationary capitalism emerging in Eastern Europe and Russia. Indeed, the breakup of the EC's exchange-rate mechanism actually will help him achieve his goal, as it relieved Germany of its costly obligation to prop up its neighbors' currencies. But Tietmeyer will have to act fast. After a 2% fall in the first half of 1993, German GDP could finish the year down by "closer to 3%," estimates Deutsche Bank Chairman Hilmar Kopper. Some economists say Germany may even see a second straight year of contraction in 1994, something it hasn't experienced since the end of World War II. "Germany is in deep stagnation," says Goldman, Sachs & Co. economist Thomas Mayer. "It will take us the rest of this decade to sort out our problems."
By all rights, such economic weakness should permit the Bundesbank to pick up the pace of interest-rate cuts. Even Tietmeyer concedes there is "more realism...on the wage front, and more realism on fiscal policy. There seem to be changes in the right direction on the way." As a result, some economists believe that overnight interest rates could fall as low as 4.5% by next year, down from 7% today. But don't count on short-term rates falling to 2% or less, as is the case in the U.S. and Japan. That's because Bundesbankers still fret that Germany's growing deficits could rekindle inflation. Commerzbank chief economist Ulrich Ramm, for example, figures that the $105 billion Bonn pumps into eastern Germany annually now represents half of the region's GDP. "Too much is going into supporting consumption and not enough into investment," Tietmeyer says.
Indeed, Bonn's heavy spending raises doubts about the realism of Tietmeyer's goal of 2% inflation within the next two to four years. Tietmeyer's ability to reduce interest rates and the mark's value thus could be limited. With the mark's trade-weighted strength against the dollar and other currencies now at a record high, that would be bad news for German exporters. But Tietmeyer hints that the exporters won't gain a swift devaluation--something the Bundesbank fears will rekindle inflation. In the 1980s, he says, "industry didn't take enough care in controlling their costs. They had the impression they were competitive, but that was artificial."
To restore his country's competitiveness, Chancellor Helmut Kohl is now banking on consumers to accede to a freeze in living standards for the first time since Germany's economic miracle began in the 1950s. As consumers forgo hikes in wages and fringe benefits and pay more for state-supported medical care, Tietmeyer is bound to face new calls to relieve the stress by easing up. With 1994 a critical election year for Kohl, Tietmeyer will have to keep an eye on politicians in Bonn. Bundesbankers still remember only four years ago, Kohl overrode them on the pace of unification, forcing the central bank to swap West German marks for nearly worthless East German ones at a rate of 1 to 1.
The dispute prompted Schlesinger's urbane predecessor, Karl Otto P ohl, to quit. But few see Tietmeyer getting into a similar dispute. Demanding and shrewd, he is nonetheless regarded as far bet-ter equipped for the Bundesbank's political and international role than the doctrinaire Schlesinger, who spent his entire career at the Bundesbank and was often uncomfortable with diplomacy.
A devout Catholic and one of 11 children of a local Treasury official from Westphalia, Tietmeyer bears few of the privileged trappings of the French-cuff global money set. He worked his way up through the political ranks of Kohl's Christian Democratic party to become state secretary in the Finance Ministry. From there Tietmeyer handled major issues including unification and the Plaza Accord to devalue the dollar. His only known recreational passion is table tennis, at which he was once a high school champion.
Sharp edges lie beneath Tietmeyer's courteous exterior. In fact, British Treasury insiders still seethe over the way they were treated by Schlesinger and Tietmeyer on the eve of the pound's departure from the European monetary grid in 1992. After Italy was forced to devalue the lire, sterling began sinking when Schlesinger stated obliquely that other currency realignments would be needed. But the real damage, the Treasury sources contend, came when Tietmeyer quietly suggested to some traders that the British currency was overvalued. That, the sources say, guaranteed the Bank of England would lose billions of dollars vainly trying to defend the pound. Tietmeyer declined to comment, but a spokesman says the Bundesbank "completely rejects" the report.
The monetary blowup this past summer reinforced the Bundesbank's power. In rolling over the EC's architects and all but shutting the failing EC foreign exchange system down, the Bundesbank ensured that it will dictate the form of any future European monetary union. Bundesbank clout is such that on Jan. 1, when a precursor to an envisioned EC central bank opens, it's almost certain to be housed in Germany--possibly in a Bundesbank building.
KEY ALLIES. Guiding the fractious European monetary preliminaries along might be a breeze compared with the reception Tietmeyer faces on the Bundesbank's restive 16-member policymaking council. With unification dramatically expanding the council's constituency and responsibilities, the discussions at the council's every-other-Thursday policy meetings have become more democratic and vocal than ever. Tietmeyer's key allies will be those who, like him, regularly aligned themselves with Schlesinger. They include Johann W. Gaddum, who is replacing Tietmeyer as vice-president, and Otmar Issing, the Bundesbank's soft-spoken chief economist and a leading candidate to succeed Tietmeyer someday. A staunch monetarist, Issing has argued for keeping rates up until the Bundesbank hits its 2% inflation target.
The Bundesbank Council is going to have more than recession and inflation to contend with, however. Massive change is sweeping Germany's financial system, transforming the culture the Bundesbank guards. Germany was a bystander during the waves of financial deregulation that swept the U.S., Britain, and other countries during the 1980s. Since unification three years ago, however, the pace of change has been frenetic. That's because Germans are no longer able to finance on their own the $140 billion-a-year public-sector deficits.
Since unification, for instance, the annual volume of mark-denominated bonds issued in the Euromarkets has exploded. Even bigger changes are taking place at home. Germany's eight stock exchanges, for example, are rapidly integrating themselves into a single electronic market better able to handle large trades. And the Deutsche Terminb orse (DTB), opened only three years ago, has seen trading in equity and debt options and futures swell. The DTB is now hooking up with France's futures market as the first step toward creating a Europe-wide network.
Corporate finance is also going modern. Like their counterparts in the U.S., German companies are now raising billions through commercial paper to supplement borrowings from their longtime bankers. Everyone from J.P. Morgan & Co. to the Union Bank of Switzerland is winning corporate-finance business away from the likes of Deutsche Bank. Daimler Benz turned to Morgan to help it peddle $2.5 billion in commercial paper in the U.S. and to Goldman, Sachs & Co. to assist it in becoming the first German manufacturer to sell stock on Wall Street. Goldman has also become a dealer in a $6.3 billion commercial-paper program for the Treuhandanstalt, the agency privatizing eastern Germany, as well as in a $1.3 billion program at the government's Telekom phone monopoly.
Managing the swift modernization of Germany's markets will pose a daunting challenge for Tietmeyer. But as he approaches the culmination of his long career in public life, his most pressing job still will have to be weighing his desire for domestic stability against Germany's growing role as a European and global power.
It is critical for Germany, and for the international economy, that Tietmeyer get it right. The Bundesbank in Frankfurt, and not the EC in Brussels, is now setting the agenda for Europe. What the Bundesbank does is going to determine whether a unified Europe anchored by a reinvigorated Germany or a continent in constant turmoil stands alongside the Americas and Japan as an engine of global growth.
"This decade should be about getting back to realities," Tietmeyer says. "If we do that in the first half of the decade, I'm pretty sure we can have new, prosperous development all over the world." Tietmeyer's version of reality, however, may not be a pleasant one for Germany's allies. For years to come, they will have to continue paying the price of a mighty mark.